Dealing with state tax issues? It comes down to domicile

Some planning and attention to the rules can protect taxpayers who have residences in more than one state.

My main office is in Florida, where the state constitution prohibits individual income tax (Fla Const. art. VII, §5). In Florida, we deal with a lot of "snowbirds," people who spend the winter months in Florida and return to their northern home state during Florida's oppressive summer. This practice can make a snowbird's income tax situation complex. The question is, How does a snowbird demonstrate Florida residency for income tax purposes to escape tax in the state he or she returns to in the summer?

Domicile and state income tax

As of 2017, Florida is one of seven states that do not have a personal income tax. (The others are Alaska, Nevada, South Dakota, Texas, Washington, and Wyoming.) Most states that have a personal income tax have a function whereby the taxpayer can file as a full-year resident, a partial-year resident, or a nonresident. Each state has its own rules as to when these filing statuses can be used.

Most snowbirds have two tax homes—one in Florida and another in their home state. They split their time between the two states. As a result, the snowbird has created two nexuses for taxation, one in the state that does not have a personal income tax, and the other in their home state, which may have a personal income tax. The income that has been earned in the other state is usually taxed under partial-year resident's status. However, what if there was a way around the oppressive state tax rules?

Let's use the state of New York as an example. New York domiciliaries pay state income taxes on all income earned anywhere. Florida domiciliaries pay New York income taxes only on income derived from "New York sources," such as rent received from a building owned in New York. In an audit, taxpayers have the burden of showing by "clear and convincing evidence" that their domicile is in Florida, i.e., that they had the intention of moving to Florida permanently, not simply that they went through the motions of moving there. You can have several "residences," but only one "domicile"—the place you always call home and the place where you always intend to return.

Determining intent is very subjective, but auditors in New York (and to a lesser extent other states with income taxes and estate taxes) use written audit guidelines to help them determine taxpayer intent (N.Y. Dep't of Tax. and Fin., Nonresident Audit Guidelines (June 2014)).

Sometimes, though, auditors do not even have to reach the issue of taxpayer intent. New York has a "statutory residency" provision (N.Y. Tax Law Section 605(b)) that says, regardless of "intent," an individual is a New York resident for tax purposes if the individual "maintains a permanent place of abode" in New York, "and spends more than one hundred eighty-three days" a year there (emphasis added).

In trying to arrive at a taxpayer's intent, the New York guidelines direct auditors to examine five "primary" factors:

The home: While the guidelines stress that "retention of a residence in New York is not, by itself, sufficient evidence to create a change in domicile," auditors are told to look carefully at the size, the value, and the nature of use of each residence, in addition to analyzing what types of "employees" (domestic help, groundskeepers, chauffeurs, etc.) are employed at each location. If a taxpayer claims to be "selling" his or her New York home, the auditors will undoubtedly ask the taxpayer to prove that he or she has really moved out, as well as look for contracts with real estate brokers and other evidence. There is no distinction between owning and renting.

Business involvement: Numerous nonresident audits are aimed at entrepreneurs who claim to have "sold" their business in New York (to their children or other insiders), retired, and moved to Florida. For taxpayers in this position, auditors will look carefully at continuing "active participation" and/or any "substantial investment in, or management of" that business; and also any active role in day-to-day decisions. Remaining in constant communication with new management, customers, or vendors can weigh against a taxpayer's asserting a change of domicile. Auditors will ask for phone and email records, correspondence, and other evidence of involvement with the New York business in trying to determine intent.

Time: The taxpayer has "passed" the Section 605(b) statutory residence test, but auditors are still told to look at a "quantitative analysis of time spent in New York in relationship to" other locations. A taxpayer would be vulnerable under this factor if, for example, he or she spent about five to six months in Florida for many years and then, without changing much else, began spending seven months of the year in Florida for the year in which the taxpayer claimed a "change" in domicile.

Items near and dear: This is sometimes referred to as the "teddy bear rule." If a person moves to Florida but left behind "sentimental" possessions (family heirlooms, works of art, books, antiques, family photo albums, etc.) which "enhance and add quality to the individual's lifestyle," the auditors will ask for bills of lading, insurance policies, and other records to show where the items are actually located during the years under audit.

Family connections: If, as one taxpayer admitted in a losing case (In re Buzzard, No. 808865 (N.Y. Div. Tax App. 4/9/92), aff'd, 613 N.Y.S.2d 294 (N.Y. App. Div. 1994)), the individual expresses a "commitment" to spend "as much time as possible" in the state (in this case, New York) with children and grandchildren, this factor could tip the balance in a nonresident audit, even though auditors are cautioned to be aware of the "intrusive nature" of the factor and to avoid the analysis unless it is absolutely necessary for their determination.

The obvious way out of being deemed domiciled in New York is to spend less than 183 days in New York. The time factor is not special to New York. Most states have some measurement of time that precludes a person who is a resident of both states from not creating an individual taxing nexus. For my clients who are snowbirds, I advise them to be physically present in Florida from October until the end of May, which is more than 183 days away from their other state.

The Florida homestead exemption

In Florida, taxpayers who can establish that their Florida home is their permanent residence will qualify for a homestead exemption, which exempts the first $50,000 of the home's value from property taxes (Fla. Const. art. VII, §6). Further, Florida's program called Save Our Homes caps the increase in the valuation for property tax to the lesser of a 3% increase or the change in the consumer price index in valuation per year, for property that qualifies for the homestead exemption (Fla Const. art VII, §4(c)).

It is an attractive taxing regime that most people in the state take advantage of, including the possibility that the limitation can be transferred between properties when residents move. However, the Save Our Homes cap and the homestead exemption can apply to only one of property for each taxpayer. If a person has more than one home in the state, he or she must choose one property.

Besides directly reducing the taxpayer's property tax bill, the homestead exemption can help establish Florida as the taxpayer's domicile. Applying for the homestead exemption in Florida, which requires taxpayers to establish that the Florida home is their principal residence, shows intent to make Florida their tax home.

Conclusion

Being domiciled in a state for tax purposes requires some planning, but can save a great deal of taxes. Each state has mechanisms to protect its residents from another state's income tax.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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